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ACCOUNTING FOR RECEIVABLES STUDY OBJECTIVES After studying this material, you should understand: TYPES OF RECEIVABLES Receivables are amounts due from individuals and other companies. There are three major classes of receivables: PRIMARY ACCOUNTING ISSUES Recognition Valuation

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slide1

ACCOUNTING FOR RECEIVABLES

STUDY OBJECTIVES

After studying this material, you should understand:

slide2

TYPES OF RECEIVABLES

Receivables are amounts due from individuals and other companies.

There are three major classes of receivables:

slide3

PRIMARY ACCOUNTING ISSUES

Recognition

Valuation

Disposition

slide4

RECOGNIZING A/R

A classic general journal sequence for credit sales.

slide5

VALUATION OF A/R

  • Receivables are current assets on the balance sheet
  • They are stated at net realizable value, the amount expected to be received in cash.
  • Uncollectible A/R are accounted for using two methods

Direct Write-Off

Method

Allowance

Method

slide6

DIRECT WRITE-OFF METHOD

  • No entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to bad debts expense.
  • Bad debt expense shows only actual losses.
  • Not acceptable for financial reporting purposes unless losses are insignificant.

Operating

expense

on the

income

statement

Bad debts expense

slide7

DIRECT WRITE-OFF METHOD

General Journal

Date

Account Titles

Debit

Credit

Dec. 12 Bad Debts Expense 200

Accounts Receivable – M.E. Doran 200

Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.

slide8

ALLOWANCE METHOD

  • The allowance method is required when bad debts are material.
  • Uncollectible accounts are estimated
  • The expense is matched against sales in the same accounting period.

Uncollectible accounts expense = bad debts expense

slide9

ALLOWANCE METHOD

RECORDING ESTIMATED UNCOLLECTIBLES

General Journal

Date

Account Titles

Debit

Credit

Dec. 31 Bad Debts Expense 12,000

Allowance for Doubtful Accounts 12,000

Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts at the end of each period.

slide10

ALLOWANCE METHOD

RECORDING A WRITE-OFF

General Journal

Date

Account Titles

Debit

Credit

Mar. 1 Allowance for Doubtful Accounts 500

Accounts Receivable - R. A. Ware 500

Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.

slide11

ALLOWANCE METHOD

RECORDING A RECOVERY

To recover an account that has been written off:

1 reverse the write-off entry.

General Journal

Date

Account Titles

Debit

Credit

July 1 Accounts Receivable – R. A. Ware 500

Allowance for Doubtful Accounts 500

2 record the collection in the usual manner.

General Journal

Date

Account Titles

Debit

Credit

July 1 Cash 500

Accounts Receivable 500

slide12

ALLOWANCE METHOD

BASIS FOR ESTIMATING UNCOLLECTIBLES

Two methods of estimating uncollectible accounts

comply with GAAP.

Percentage of Sales

Percentage of Receivables

Emphasis on Income

Statement Relationships

Emphasis on Balance

Sheet Relationships

Uses aging schedule

slide13

Dec.3 1 Bad Debts Expense 8,000

Allowance for Doubtful Accounts 8,000

ALLOWANCE METHOD

PERECENTAGE OF SALES BASIS

  • Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience.
  • Matches expenses with revenues.
  • No consideration given to existing balance in the allowance.

If net credit sales for the year are $800,000, the estimated

bad debts expense is $8,000 (1% X $800,000).

slide14

ALLOWANCE METHOD

PERECENTAGE OF RECEIVABLES BASIS

  • Bad debt expense based on % of the ending balance in A/R.
  • The adjusting entry is the difference between the required balance and the existing balance in the allowance account.
  • Estimates NRV of receivables.

General Journal

Date

Account Titles

Debit

Credit

Dec. 31 Bad Debts Expense 1,700

Allowance for Doubtful Accounts 1,700

If the existing balance in the allowance account is $500 credit, and the required balance is $2,200, the journal entry to increase the allowance will be for the difference between the required balance and the existing balance.

slide15

If the existing balance in the allowance account is $500 debit, and the required balance is $2,200, the journal entry to increase the allowance will be for the sum of the required balance and existing balance.

General Journal

Date

Account Titles

Debit

Credit

Dec. 31 Bad Debts Expense 2,700

Allowance for Doubtful Accounts 2,700

slide16

REVIEW QUESTION

Which of the following approaches for bad debts

is referred to as a balance sheet method?

  • Percentage of receivables method
  • Direct write-off method
  • Percentage of sales method
  • Both a and b

Answer: (A) Percentage of receivables method.

slide17

FINANCIAL STATEMENT

PRESENTATION & ANALYSIS

  • In the balance sheet, short-term receivables are reported in the current assetssection belowshort-term investments.
  • Report both the gross amount of receivables and the allowance for doubtful accounts.
slide18

Average

Net Receivables

Accounts

Receivable

Turnover

Net Credit

Sales

A/R TURNOVER RATIO

  • Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable.
  • The accounts receivables turnover ratio is used to assess the liquidity of the receivables.
  • The data below is from Cisco Systems:

=

/

  • $18,878 / ( $1,105 + $1,351)/2 = 15.4 times
slide19

AVERAGE COLLECTION PERIOD

  • The average collectionperiodin days is a variant of the turnover ratio that makes liquidity even more evident.
  • This is done by dividing the turnover ratio into 365 days.
  • The general ruleis that the collection period should not exceed the credit term period.
  • Cisco System’s turnover ratio is computed as:

Days in year

A/R Turn

Ratio

Average

Collection

Period

=

/

365 / 15.4 23.7 days